Banks Will Have to Beef up Capital Buffers for Fund Investments

Banks will have to hold more capital to cover investments in some "shadow banks," such as hedge funds and private equity, from January 2017, global regulators said on Friday.

The new rule is part of wider efforts by the Group of 20 economies to contain risks in the $70 trillion shadow banking sector, which was criticized for its opacity by regulators during the 2007/09 financial crisis.

The rule, written by the Basel Committee of global banking supervisors, covers investments by banks in all types of funds, including plainer and less risky mutual funds, to harmonize how they are treated by regulators worldwide.

Banks work out how much capital they must hold by assigning "risk weights" to investments and assets they hold.

Currently investments in funds have a relatively moderate weighting of up to 150 percent, which can leave bank's shareholders in the dark over the true level of risk on the lender's core book.

Under the new rule, banks will have to be able to show regulators that a fund investment is low-risk or be saddled with a risk weighting of 1,250 percent.

This would mean having to set aside capital roughly equal to the investment itself, a punitive charge that regulators hope will give banks a clear incentive to ensure they have a thorough understanding of the investment and are therefore able to identify an adequate level of capital cover.

Basel ignored calls for significant changes to the draft rule put out for consultation earlier this year, retaining a three-stage approach to totting up risks from investments in funds.

The more due diligence banks carry out, the more favorable the capital treatment will be.

The Institute of International Finance, a global banking industry body, and the Association for Financial Markets in Europe, had criticized the 1,250 percent risk weighting as being out of proportion and sought a reduction to 400 percent.

Basel also rejected industry calls for an investment threshold below which the three-stage approach would not apply.